SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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Form 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
Commission File No. 1-7797
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PHH Corporation
(Exact name of Registrant as specified in its charter)
Maryland 52-0551284
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification Number)
organization)
6 Sylvan Way
Parsippany, New Jersey 07054
(Address of principal executive (Zip Code)
office)
(973) 428-9700
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if applicable)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [ ] No [ ]
The Company meets the conditions set forth in General Instruction H(1)(a)
and (b) of Form 10-Q and is, therefore, filing this Form with the reduced
disclosure format.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHH Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
As Restated (Note 2)
----------------------------
Three Months Ended
March 31,
----------------------------
1998 1997
------------ -------------
Revenues
Fleet management services $ 55,431 $ 5,962
6,576
Relocation services, net of interest 99,653 84,756
Mortgage services (net of amortization of
mortgage servicing rights and
interest of $48,076, and $30,110, respectively) 77,996 33,632
----------- -------------
Service fees - net 233,080 184,964
Fleet leasing (net of depreciation and interest
costs of $311,564 and $286,075, respectively) 19,896 14,219
----------- -------------
Net revenues 252,976 199,183
----------- -------------
Expenses
Operating 110,918 91,937
General and administrative 36,616 44,250
Depreciation and amortization 7,477 6,956
Merger-related costs and other unusual charges 3,141 -
----------- -------------
Total expenses 158,152 143,143
----------- -------------
Income before income taxes 94,824 56,040
Provision for income taxes 32,681 23,618
----------- -------------
Net income $ 62,143 $ 32,422
=========== =============
See accompanying notes to consolidated financial statements.
PHH Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands)
As Restated
(Note 2)
-------------
March 31, December 31,
1998 1997
------------- -------------
Assets
Cash and cash equivalents $ 59,403 $ 2,102
Restricted cash 13,068 23,727
Accounts and notes receivable,
net of allowance for doubtful accounts 645,327 567,598
Other assets 375,679 423,323
------------- -------------
Total assets exclusive of assets under programs 1,093,477 1,016,750
------------- -------------
Assets under management and mortgage programs
Net investment in leases and leased vehicles 3,812,610 3,659,049
Relocation receivables 649,673 775,284
Mortgage loans held for sale 1,795,783 1,636,341
Mortgage servicing rights 408,933 373,049
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6,666,999 6,443,723
------------- -------------
Total assets $ 7,760,476 $ 7,460,473
============= =============
See accompanying notes to consolidated financial statements.
PHH Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
As Restated
(Note 2)
-------------
March 31, December 31,
1998 1997
------------- -------------
Liabilities and shareholder's equity
Accounts payable and accrued liabilities $ 733,518 $ 692,471
Deferred revenue 59,655 53,261
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Total liabilities exclusive of liabilities under programs 793,173 745,732
------------- -------------
Liabilities under management and mortgage programs
Debt 5,796,886 5,602,600
------------- -------------
Deferred income taxes 298,513 295,707
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Total liabilities 6,888,572 6,644,039
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Commitments and contingencies (Note 6)
Shareholder's equity
Preferred stock - authorized 3,000,000 shares -- --
Common stock, no par value - authorized 75,000,000 shares;
issued and outstanding 100 shares 289,157 289,157
Retained earnings 606,860 544,716
Accumulated other comprehensive loss (24,113) (17,439)
-------------- --------------
Total shareholder's equity 871,904 816,434
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Total liabilities and shareholder's equity $ 7,760,476 $ 7,460,473
============= =============
See accompanying notes to consolidated financial statements.
PHH Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
As Restated (Note 2)
-------------------------------
Three Months Ended
March 31,
1998 1997
------------- -------------
Operating Activities
Net income $ 62,143 $ 32,422
Payments of merger-related costs and other
unusual charge liabilities (22,495) --
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 7,477 6,956
Other 7,509 62,737
Management and mortgage programs:
Depreciation and amortization 278,460 281,412
Mortgage loans held for sale (159,442) 32,876
-------------- -------------
Net cash provided by operating activities 173,652 416,403
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Investing Activities
Additions to property and equipment - net (27,758) (5,962)
Other 6,916 1,519
Management and mortgage programs:
Investment in leases and leased vehicles (626,170) (690,212)
Payments received on investment in leases and leased vehicles 222,021 268,790
Proceeds from sales and transfers of leases and leased vehicles
to third parties 27,284 84,825
Equity advances on homes under management (1,436,765) (900,583)
Repayment of advances on homes under management 1,564,453 962,122
Additions to mortgage servicing rights (109,486) (41,691)
Proceeds from sales of mortgage servicing rights 39,852 --
------------- -------------
Net cash used in investing activities (339,653) (321,192)
-------------- --------------
Financing Activities
Proceeds received from parent company capital contribution 46,000 --
Other -- (1,278)
Management and mortgage programs:
Proceeds from debt issuance or borrowings 983,808 324,508
Principal payments on borrowings (449,096) (880,064)
Net change in short-term borrowings (340,426) 422,622
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Net cash provided by (used in) financing activities 240,286 (134,212)
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Effect of exchange rates on cash and cash equivalents (16,984) 38,366
------------- ---------------
Increase (decrease) in cash and cash equivalents 57,301 (635)
Cash and cash equivalents at beginning of period 2,102 13,779
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Cash and cash equivalents at end of period $ 59,403 $ 13,144
============= =============
See accompanying notes to consolidated financial statements.
PHH Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
PHH Corporation, together with its wholly-owned subsidiaries, (the
"Company") is a leading provider of corporate relocation, fleet management
and mortgage services. In April 1997, the Company merged with HFS
Incorporated ("HFS") (the "HFS Merger") and on December 17, 1997, HFS
together with the Company, was merged with and into CUC International Inc.
("CUC") to form Cendant Corporation ("Cendant" or the "Parent Company"),
(the "Cendant Merger"). Effective with the Cendant Merger, the Company
became a wholly-owned subsidiary of Cendant. However, pursuant to certain
covenant requirements under the indentures in which the Company issues
debt, the Company continues to operate and maintain its status as a
separate public reporting entity, which is the basis under which the
accompanying financial statements and footnotes are presented.
The accompanying unaudited financial statements and notes hereto have been
restated for certain adjustments as described in Note 2 and have been
updated to disclose reportable events through the date of this filing. The
consolidated balance sheet of the Company as of March 31, 1998, the
consolidated statements of operations for the three months ended March 31,
1998 and 1997 and the consolidated statements of cash flows for the three
months ended March 31, 1998 and 1997 are unaudited. The accompanying
unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the instructions of Form 10-Q and Rule 10-01
of Regulation S-X. The December 31, 1997 consolidated balance sheet was
derived from the Company's audited financial statements included in the
Company's Annual Report on Form 10-K/A for the year ended December 31, 1997
(filed with the Securities and Exchange Commission on October 26, 1998) and
should be read in conjunction with such consolidated financial statements
and notes thereto.
In the opinion of management, all adjustments (consisting of normal
recurring accruals, except as discussed in Note 2) considered necessary for
a fair presentation have been included. Operating results for the three
months ended March 31, 1998 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
Certain reclassifications have been made to the 1997 consolidated financial
statements to conform to the presentation used in 1998.
2. Restatement
Subsequent to the issuance of the consolidated financial statements for the
quarterly period ended March 31, 1998, management determined that there
were errors in the financial statements. Adjustments to correct these
errors resulted in a decrease in net income of $1.6 million ($0.8 million
increase in net income excluding merger-related costs and other unusual
charges ("Unusual Charges")) and $2.2 million in 1998 and 1997,
respectively. Errors relate to the accrual and classification of Unusual
Charges and, in 1997, errors made in conforming the accounting policies
when the Company's relocation business was merged with HFS's relocation
business. The financial position as of March 31, 1998 and results of
operations for the three months ended March 31, 1998 and 1997 have been
restated to adjust Unusual Charges and to reflect the impact of the
accounting changes to conform accounting policies.
Provided below is a reconciliation of the financial results from amounts
previously reported to the restated amounts. Certain reclassifications
have been made to the previously reported three months ended March 31, 1997
financial statements to conform to the 1998 presentation.
Statement of Operations
(In thousands)
Three Months Ended March 31, 1998
------------------------------------------------
Adjustments
As previously for accounting As
reported errors restated
------------- -------------- -------------
Net revenues $ 252,976 $ - $ 252,976
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Expenses
Operating 110,083 835 110,918
General and administrative 38,936 (2,320) 36,616
Depreciation and amortization 7,102 375 7,477
Merger-related costs and other
unusual charges - 3,141 3,141
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Total expenses 156,121 2,031 158,152
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Income (loss) before income taxes 96,855 (2,031) 94,824
Provision (benefit) for income taxes 33,101 (420) 32,681
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Net income (loss) $ 63,754 $ (1,611) $ 62,143
============= ============== =============
Three Months Ended March 31, 1997
------------------------------------------------
Adjustments
As previously for accounting As
reported errors restated
------------- -------------- -------------
Net revenues $ 199,672 $ (489) $ 199,183
------------- -------------- -------------
Expenses
Operating 89,505 2,432 91,937
General and administrative 44,248 2 44,250
Depreciation and amortization 6,979 (23) 6,956
------------- -------------- -------------
Total expenses 140,732 2,411 143,143
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Income (loss) before income taxes 58,940 (2,900) 56,040
Provision (benefit) for income taxes 24,300 (682) 23,618
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Net income (loss) $ 34,640 $ (2,218) $ 32,422
============= ============== =============
Balance Sheet
(In thousands)
At March 31, 1998
-----------------------------------------------------
Adjustments
As previously for accounting As
reported errors restated
---------------- ---------------- -------------
Assets
Cash and cash equivalents $ 48,629 $ 10,774 $ 59,403
Restricted cash 23,842 (10,774) 13,068
Receivables, net 648,384 (3,057) 645,327
Other assets 376,484 (805) 375,679
---------------- ---------------- -------------
Total assets exclusive of
assets under programs 1,097,339 (3,862) 1,093,477
---------------- ---------------- -------------
Assets under management
and mortgage programs 6,666,999 - 6,666,999
---------------- --------------- -------------
Total assets $ 7,764,338 $ (3,862) $ 7,760,476
================ ================ =============
Liabilities and shareholder's equity
Accounts payable and accrued liabilities $ 736,731 $ (3,213) $ 733,518
Deferred revenue 59,166 489 59,655
---------------- --------------- -------------
Total liabilities exclusive of
liabilities under programs 795,897 (2,724) 793,173
---------------- ---------------- -------------
Liabilities under management
and mortgage programs 6,095,399 - 6,095,399
---------------- --------------- -------------
Total shareholder's equity 873,042 (1,138) 871,904
---------------- ---------------- -------------
Total liabilities and shareholder's equity $ 7,764,338 $ (3,862) $ 7,760,476
================ ================ =============
3. Merger-Related Costs and Other Unusual Charges
The Company incurred aggregate merger-related costs and other unusual
charges in 1997 of $251.0 million primarily associated with an coincident
to the Cendant Merger and the HFS Merger. The remaining liabilities at
December 31, 1997 and reduction of such liabilities for the three months
ended March 31, 1998 are summarized by category of expenditure and by
merger as follows:
Liabilities at Liabilities at
December 31, Cash March 31,
(In thousands) 1997 Payments Adjustments 1998
-------------- ------------- ------------- -------------
Professional fees $ 690 $ 1,955 $ 1,873 $ 608
Personnel related 53,025 14,857 1,268 39,436
Business terminations 1,507 551 - 956
Facility related and other 15,545 5,132 - 10,413
-------------- ------------- ------------- -------------
Total $ 70,767 $ 22,495 $ 3,141 $ 51,413
============== ============= ============= =============
Liabilities at Liabilities at
December 31, Cash March 31,
(In thousands) 1997 Payments Adjustments 1998
-------------- ------------- ------------- -------------
Cendant Merger $ 12,236 $ 12,647 $ 1,873 $ 1,462
HFS Merger 58,531 9,848 1,268 49,951
-------------- ------------- ------------- -------------
Total $ 70,767 $ 22,495 $ 3,141 $ 51,413
============== ============= ============= =============
During the three months ended March 31, 1998, the Company incurred $1.9
million of Unusual Charges related to the Cendant Merger associated with
professional fees and $1.3 million of Unusual Charges related to the HFS
Merger associated with severance costs that were period costs and
accordingly not accrued at December 31, 1997.
The remaining personnel related liabilities relate to future severance and
benefit payments and the facility related liabilities are for future lease
termination payments.
4. Comprehensive Income
The Company adopted Statement of Accounting Standards No. 130 "Reporting
Comprehensive Income" effective January 1, 1998. This statement establishes
standards for the reporting and display of an alternative income
measurement and its components in the financial statements.
Components of comprehensive income are summarized as follows:
Three Months Ended March 31,
----------------------------------------
1998 1997
------------- --------------
(In thousands)
Net income $ 62,143 $ 32,422
Other comprehensive loss:
Currency translation adjustment (6,674) (6,009)
-------------- ---------------
Comprehensive income $ 55,469 $ 26,413
============= ==============
5. New Accounting Standard
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities" effective for all quarterly and annual
periods beginning after June 15, 1999. SFAS No. 133 requires the
recognition of all derivatives in the consolidated balance sheet as either
assets or liabilities measured at fair value. The Company will adopt SFAS
No. 133 effective January 1, 2000. The Company has not yet determined the
impact SFAS No. 133 will have on its financial position or results of
operations when such statement is adopted.
6. Parent Company Investigation and Litigation
Parent Company Investigation and Litigation. On April 15, 1998, Cendant
announced that it discovered accounting irregularities in the former CUC
business units. Since the Parent Company's announcement and prior to the
date hereof, seventy-one purported class action lawsuits and one individual
lawsuit have been filed against the Parent Company and certain current and
former officers and directors of the Parent Company and HFS, asserting
various claims under the federal securities laws (the "Federal Securities
Actions"). Some of the actions also name as defendants Merrill Lynch & Co.
and, in one case, Chase Securities, Inc., underwriters for the Parent
Company's PRIDES securities offering; two others also name Ernst & Young
LLP, the Parent Company's former independent accountants. Sixty-four
of the Federal Securities Actions were filed in the United States
District Court for the District of New Jersey, six were filed in the
United States District Court for the District of Connecticut (including
the individual action), one was filed in the United States District Court
for the Eastern District of Pennsylvania and one has been filed in New
Jersey Superior Court. The Federal Securities Actions filed in the
District of Connecticut and Eastern District of Pennsylvania have
been transferred to the District of New Jersey. On June 10, 1998, the
Parent Company moved to dismiss or stay the Federal Securities
Actions filed in New Jersey Superior Court on the ground that, among other
things, it is duplicative of the actions filed in federal courts. The
court granted that motion on August 7, 1998, without prejudice to the
plaintiff's right to re-file the case in the District of New Jersey.
Certain of these Federal Securities Actions purport to be brought on behalf
of purchasers of the Parent Company's common stock and/or options on common
stock during various periods, most frequently beginning May 28, 1997 and
ending April 15, 1998 (although the alleged class periods begin as early as
March 21, 1995 and end as late as July 15, 1998). Others claim to be
brought on behalf of persons who exchanged common stock of HFS for the
Parent Company's common stock in connection with the Merger. Some
plaintiffs purport to represent both of these types of investors. In
addition, eight actions pending in the District of New Jersey purport to be
brought, either in their entirety or in part, on behalf of purchasers of
the Parent Company's PRIDES securities. The complaints in the Federal
Securities Actions allege, among other things, that as a result of
accounting irregularities, the Parent Company's previously issued financial
statements were materially false and misleading and that the defendants
knew or should have known that these financial statements caused the prices
of the Parent Company's securities to be inflated artificially. The Federal
Securities Actions variously allege violations of Section 10(b) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule
10b-5 promulgated thereunder, Section 14(a) of the Exchange Act and Rule
14a-9 promulgated thereunder, Section 20(a) of the Exchange Act, and
Sections 11, 12 and 15 of the Securities Act of 1933, as amended (the
"Securities Act"). Certain actions also allege violations of common law.
The individual action also alleges violations of Section 18(a) of the
Exchange Act and the Florida securities law. The class action complaints
seek damages in unspecified amounts. The individual action seeks damages in
the amount of approximately $9 million plus interest and expenses.
On May 29, 1998, United States Magistrate Judge Joel A. Pisano entered an
Order consolidating the 50 Federal Securities Actions that had at that time
been filed in the United States District Court for the District of New
Jersey, under the caption In re: Cendant Corporation Litigation, Master
File No. 98-1664 (WHW). Pursuant to the Order, all related actions
subsequently filed in the District of New Jersey are to be consolidated
under that caption. United States District Court Judge William H. Walls has
selected lead plaintiffs to represent all potential class members in the
consolidated action. He has also ordered that applications seeking
appointment as lead counsel to represent the lead plaintiffs are to be
filed with the Court by September 17, 1998. The selection of lead counsel
is pending.
In addition, on April 27, 1998, a purported shareholder derivative action,
Deutch v Silverman, et al., No. 98-1998 (WHW), was filed in the District of
New Jersey against certain of the Parent Company's current and former
directors and officers; The Bear Stearns Companies, Inc.; Bear Stearns &
Co. Inc.; and, as a nominal party, the Parent Company. The complaint in the
Deutch action alleges that certain individual officers and directors of the
Parent Company breached their fiduciary duties by selling shares of the
Parent Company's stock while in possession of non-public material
information concerning the accounting irregularities. The complaint also
alleges various other breaches of fiduciary duty, mismanagement, negligence
and corporate waste and seeks damages on behalf of the Parent Company.
Another action, entitled Corwin v Silverman, et al., No. 16347-NC, was
filed on April 29, 1998 in the Court of Chancery for the State of Delaware.
The Corwin action is purportedly brought both derivatively, on behalf of
the Parent Company, and as a class action, on behalf of all shareholders of
HFS who exchanged their HFS shares for the Parent Company's shares in
connection with the Merger. The Corwin action names as defendants HFS and
twenty-eight individuals who are and were directors of Cendant and HFS. The
complaint in the Corwin action alleges that defendants breached their
fiduciary duties of loyalty, good faith, care and candor in connection with
the Merger, in that they failed to properly investigate the operations and
financial statements of the Parent Company before approving the Merger at
an allegedly inadequate price. The amended compliant also alleges that the
Parent Company's directors breached their fiduciary duties by entering into
an employment agreement with Cendant's former Chairman, Walter Forbes, in
connection with the Merger that purportedly amounted to corporate waste.
The Corwin action seeks, among other things, recision of the Merger and
compensation for all losses and damages allegedly suffered in connection
therewith.
The staff of the Securities and Exchange Commission (the "SEC") and the
United States Attorney for the District of New Jersey are conducting
investigations relating to the matters referenced above. The SEC staff has
advised the Parent Company that its inquiry should not be construed as an
indication by the SEC or its staff that any violations of law have
occurred.
In connection with the Merger, certain officers and directors of HFS
exchanged their shares of HFS common stock and options exercisable for HFS
common stock for shares of the Parent Company's common stock and options
exercisable for the Parent Company's common stock, respectively. As a
result of the aforementioned accounting irregularities, such officers and
directors have advised the Parent Company that they believe they have
claims against the Parent Company in connection with such exchange. In
addition, certain current and former officers and directors of the Parent
Company would consider themselves to be members of any class ultimately
certified in the Federal Securities Actions now pending in which the Parent
Company is named as a defendant by virtue of their having been
HFS stockholders at the time of the Merger.
While it is not feasible to predict or determine the final outcome of these
proceedings or to estimate the amounts or potential range of loss with
respect to these matters, management believes that an adverse outcome with
respect to such Parent Company proceedings could have a material adverse
impact on the financial condition and cash flows of the Company.
Other pending litigation. The Company and its subsidiaries are involved in
pending litigation in the usual course of business. In the opinion of
management, such litigation will not have a material effect on the
Company's consolidated financial position, results of operations or cash
flows.
7. Subsequent Event
Mortgage Facility. The Company's mortgage services subsidiary ("Mortgage
Services") entered into a three year agreement effective May, 1998 (the
"Effective Date") under which an unaffiliated Buyer (the "Buyer") has
committed to purchase, at Mortgage Services' option, mortgage loans
originated by Mortgage Services on a daily basis, up to the Buyer's asset
limit of $1.5 billion.
Under the terms of this sale agreement, Mortgage Services retains the
servicing rights on the mortgage loans sold to the Buyer and provides the
Buyer with options to sell or securitize the mortgage loans into the
secondary market.
Item 2. Management's Narrative Analysis of Results of Operations and Liquidity
and Capital Resources
General Overview
PHH Corporation, together with its wholly-owned subsidiaries, (the "Company") is
a leading provider of corporate relocation, fleet management and mortgage
services. In April 1997, the Company merged with HFS Incorporated ("HFS") (the
"HFS Merger") and in December 1997, HFS, together with the Company, was merged
with and into CUC International Inc. ("CUC") to form Cendant Corporation (the
"Cendant Merger"). Effective with the Cendant Merger, the Company became a
wholly-owned subsidiary of Cendant Corporation ("Cendant" or the "Parent
Company). However, pursuant to certain covenant requirements under the
indentures in which the Company issues debt, the Company continues to operate
and maintain its status as a separate public reporting entity.
As part of Cendant's ongoing evaluation of its business units, the Company
may from time to time explore its ability to make divestitures and enter into
related transactions as they arise. No assurance can be given that any
divestiture or other transaction will be consummated or, if consummated, the
magnitude, timing, likelihood or financial or business effect on the Company of
such transactions. Among the factors the Company will consider in determining
whether or not to consummate any transaction is the strategic and financial
impact of such transaction on the Company and Cendant, including the impact, if
any, on the pooling of interests accounting treatment of prior acquisitions by
Cendant, including the HFS Merger and the Cendant Merger.
Results of Operations
This discussion should be read in conjunction with the information contained in
the Consolidated Financial Statements and accompanying Notes thereto of the
Company appearing elsewhere in this Form 10-Q/A.
Net Revenue
Net revenue of the Company increased $53.8 million (27%) from $199.2 million in
1997 to $253.0 million in 1998. The increase reflects higher revenues in the
Company's real estate segment (relocation and mortgage services businesses)
partially offset by a $5.5 million (7%) decrease in fleet management net
revenue. The decrease in fleet management net revenue results from a $12.8
reduction in preferred alliance revenue for the comparative quarters net of a
$7.3 million (12%) increase in both service fees and asset-based fees from its
various vehicle management and maintenance programs. Real estate net revenue of
$177.6 million in 1998 reflected a $59.3 million or 50% increase from 1997. The
real estate segment experienced higher revenue within each of its underlying
relocation and mortgage services businesses. Relocation services net revenue
increased 18% from $84.8 million in 1997 to $99.7 million in 1998 which was
primarily attributable to increased transaction volume in its government home
sale assistance program. Mortgage services net revenue increased 132% from $33.6
million in 1997 to $78.0 million in 1998 primarily as a result of a $34.7
million (202%) increase in loan origination revenue, resulting from an increase
in the volume of loan closings and a $7.7 million (115%) increase in loan
servicing fees.
Operating Margins
Total Company's operating margin increased from 28% in 1997 to 37% in 1998. Such
margin improvements primarily resulted from the increased volume of service
transactions discussed above as well as operational efficiencies realized
principally from the restructuring of the Company's fleet management and
relocation businesses in connection with the aforementioned mergers.
Liquidity And Capital Resources
The Company manages its funding sources to ensure adequate liquidity. The
sources of liquidity fall into three general areas: ongoing liquidation of
assets under management, global capital markets, and committed credit agreements
with various high-quality domestic and international banks. In the ordinary
course of business, the liquidation of assets under management programs, as well
as cash flows generated from operating activities, provide the cash flow
necessary for the repayment of existing liabilities.
Using historical information, the Company projects the time period that a
client's vehicle will be in service or the length of time that a home will be
held in inventory before being sold on behalf of the client. Once the relevant
asset characteristics are projected, the Company generally matches the projected
dollar amount, interest rate and maturity characteristics of the assets within
the overall funding program. This is accomplished through stated debt terms or
effectively modifying such terms through other instruments, primarily interest
rate swap agreements and revolving credit agreements. Within mortgage banking
services, the Company funds the mortgage loans on a short-term basis until the
mortgage loans are sold to unrelated investors, which generally occurs within
sixty days. Interest rate risk on mortgages originated for sale is managed
through the use of forward delivery contracts, financial futures and options.
Financial derivatives are also used as a hedge to minimize earnings volatility
as it relates to mortgage servicing assets.
The Company supports purchases of leased vehicles, equity advances, and mortgage
originations primarily by issuing commercial paper and medium term notes. Such
borrowings are included in liabilities under management and mortgage programs
rather than long-term debt since such debt corresponds directly with high
quality related assets. In addition, the Company has successfully completed and
continually pursues opportunities to reduce its borrowing requirements by
securitizing increasing amounts of its high quality assets. In May 1998, the
Company commenced a program to sell originated mortgage loans to an unaffiliated
buyer, at the option of the Company, up to the buyer's asset limit of $1.5
billion. The buyer may sell or securitize such mortgage loans into the secondary
market, however, servicing rights are retained by the Company.
Pursuant to certain covenant requirements under the indentures in which the
Company issues debt, the Company continues to operate and maintain its status as
a separate public reporting entity. Financial covenants are designed to ensure
the self-sufficient liquidity status of the Company. Financial covenants include
restrictions on Parent Company loans, debt to equity, and other separate Company
financial restrictions.
In October 1998, Moody's and Standard and Poor's reduced the Company's long-term
and short-term debt ratings to A3/P2 and A-/A2 from A2/P1 and A+/A1,
respectively. The Company's long-term and short-term debt ratings remain A+F1
and A+/D1 with Fitch IBCA and Duff & Phelps, respectively. While the recent
downgrading caused the Company to incur an increase in cost of funds, management
believes its sources of liquidity continue to be adequate. (A security rating is
not a recommendation to buy, sell or hold securities and is subject to revision
or withdrawal at any time.)
The Company expects to continue to have broad access to global capital markets
by maintaining the quality of its assets under management. This is achieved by
establishing credit standards to minimize credit risk and the potential for
losses. Depending upon asset growth and financial market conditions, the Company
utilizes the United States, European and Canadian commercial paper markets, as
well as other cost-effective short-term instruments. In addition, the Company
will continue to utilize the public and private debt markets as sources of
financing. Augmenting these sources, the Company will continue to manage
outstanding debt with the potential sale or transfer of managed assets to third
parties while retaining fee-related servicing responsibility. At March 31, 1998,
the Company's outstanding debt was comprised of commercial paper, medium term
notes and other borrowings of $2.2 billion, $3.4 billion, and $.2 billion,
respectively.
The Company filed a shelf registration statement with the Securities and
Exchange Commission ("SEC") effective March 2, 1998, for the aggregate issuance
of up to $3 billion of medium-term note debt securities. These securities may be
offered from time to time, together or separately, based on terms to be
determined at the time of sale. The proceeds will be used to finance assets the
Company manages for its clients and for general corporate purposes. As of July
31, 1998, the Company had issued $795 million of medium-term notes under this
shelf registration statement.
To provide additional financial flexibility, the Company's current policy is to
ensure that minimum committed bank facilities aggregate 80 percent of the
average amount of outstanding commercial paper. The Company maintains a $2.5
billion syndicated unsecured credit facility which is backed by domestic and
foreign banks and is comprised of $1.25 billion lines of credit maturing in 364
days and $1.25 billion maturing in the year 2000. In addition, the Company has a
$200 million revolving credit facility, which matures on June 24, 1999 and has
approximately $186 million of uncommitted lines of credit with various financial
institutions. Management closely evaluates the credit quality of the banks and
also the terms of the various agreements to ensure ongoing availability. The
full amount of the Company's committed facilities at March 31, 1998 was undrawn
and available. Management believes that its current policy provides adequate
protection should volatility in the financial markets limit the Company's access
to commercial paper or medium-term notes funding.
On July 10, 1998, the Parent Company entered into a Supplemental Indenture No. 1
(the "Supplemental Indenture") with The First National Bank of Chicago, as
trustee, under the Senior Indenture dated as of June 5, 1997, which formalizes
the policy for the Company of limiting the payment of dividends and the
outstanding principal balance of loans to the Parent Company to 40% of
consolidated net income (as defined in the Supplemental Indenture) for each
fiscal year. The Supplemental Indenture prohibits the Company from paying
dividends or making loans to the Parent Company if upon giving effect to such
dividends and/or loan, the Company's debt to equity ratio exceeds 8 to 1.
Cash Flow
Cash flow provided by operating activities for the 1998 quarter was $173.7
million compared to $416.4 million for the 1997 quarter. Operating cash flows in
1998 reflects an incremental cash use of $192.3 million versus 1997 related to
the $2.8 billion increase in mortgage loan originations. Cash flow provided by
operating activities for the 1998 quarter also included $22.5 million of
merger-related cash payments associated with the HFS Merger and the Cendant
Merger which occurred during the second and fourth quarters of 1997,
respectively.
Parent Company Litigation
On April 15, 1998, Cendant announced that it discovered accounting
irregularities in certain former CUC business units. Cendant, together with its
legal counsel and assisted by external auditors, conducted an investigation of
these accounting irregularities. In addition, the Audit Committee of Cendant's
Board of Directors initiated an investigation into such matters. As a result of
the findings of these investigations and a concurrent internal financial review
process by Cendant which revealed both accounting errors and irregularities,
Cendant restated its previously reported financial statements for the years
ended December 31, 1997, 1996 and 1995 and the 1998 quarterly periods ended
March 31, and June 30.
Numerous purported class action lawsuits, two purported derivative lawsuits and
an individual lawsuit have been filed against the Parent Company and, among
others, its predecessor HFS, and certain current and former officers and
directors of the Parent Company and HFS asserting various claims under the
federal securities laws and certain state statutory and common laws. In
addition, the staff of the SEC and the United States Attorney for the District
of New Jersey are conducting investigations relating to the accounting issues.
The SEC staff advised the Parent Company that its inquiry should not be
construed as an indication by the SEC or its staff that any violations of law
have occurred. See Note 6 to the Consolidated Financial Statements.
While it is not feasible to predict or determine the final outcome of these
proceedings or to estimate the amounts or potential range of loss with respect
to these matters, management believes that an adverse outcome with respect to
Parent Company proceedings could have a material impact on the financial
condition and cash flows of the Company.
Impact of New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
131 "Disclosures About Segments of an Enterprise and Related Information"
effective for annual periods beginning after December 15, 1997 and interim
periods subsequent to the initial year of application. SFAS No. 131 establishes
standards for the way that public business enterprises report information about
their operating segments in their annual and interim financial statements. It
also requires public enterprises to disclose company-wide information regarding
products and services and the geographic areas in which they operate. The
Company will adopt SFAS No. 131 effective for the 1998 calendar year end.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures about
Pension and Other Postretirement Benefits" effective for periods beginning after
December 15, 1997. The Company will adopt SFAS No. 132 effective for the 1998
calendar year end.
The aforementioned recently issued accounting pronouncements establish standards
for disclosures only and therefore will have no impact on the Company's
financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" effective for all quarterly and annual
periods beginning after June 15, 1999. SFAS No. 133 requires the recognition of
all derivatives in the consolidated balance sheet as either assets or
liabilities measured at fair value. The Company will adopt SFAS No. 133
effective January 1, 2000. The Company has not yet determined the impact SFAS
No. 133 will have on its financial statements.
Year 2000 Compliance
The Year 2000 presents the risks that information systems will be unable to
recognize the process date-sensitive information properly from and after January
1, 2000.
To minimize or eliminate the effect of the year 2000 risk on the Company's
business systems and applications, the Company is continually identifying,
evaluating, implementing and testing changes to its computer systems,
applications and software necessary to achieve Year 2000 compliance. The Company
has selected a team of managers to identify, evaluate and implement a plan to
bring all of the Company's critical business systems and applications into Year
2000 compliance prior to December 31, 1999. The Year 2000 initiative consists of
four phases: (i) identification of all critical business systems subject to Year
2000 risk (the "Identification Phase"); (ii) assessment of such business systems
and applications to determine the method of correcting any Year 2000 problems
(the "Assessment Phase"); (iii) implementing the corrective measures (the
"Implementation Phase"); and (iv) testing and maintaining system compliance (the
"Testing Phase"). The Company has substantially completed the Identification and
Assessment Phases and has identified and assessed five areas of risk: (i)
internally developed business applications; (ii) third party vendor software,
such as business applications, operating systems and special function software;
(iii) computer hardware components; (iv) electronic data transfer systems
between the Company and its customers; and (v) embedded systems, such as phone
switches check writers and alarm systems. Although no assurance can be made, the
Company believes that it has identified substantially all of its systems,
applications and related software that are subject to Year 2000 compliance risks
and has either implemented or initiated the implementation of a plan to correct
such systems that are not Year 2000 compliant. The Company has targeted December
31, 1998 for completion of the Implementation Phase. Although the Company has
begun the Testing Phase, it does not anticipate completion of the Testing Phase
until sometime prior to December 1999.
The Company relies on third party service providers for services such as
telecommunications, internet service, utilities, components for its embedded and
other systems and other key services. Interruption of those services due to Year
2000 issues could affect the Company's operations. The Company initiated an
evaluation of the status of such third party service providers' efforts to
determine alternative and contingency requirements. While approaches to reducing
risks of interruption of business operations vary by business unit, options
include identification of alternative service providers available to provide
such services if a service provider fails to become Year 2000 compliance within
an acceptable timeframe prior to December 31, 1999.
The total cost of the Company's Year 2000 compliance plan is anticipated to be
$23 million. Approximately $12 million of these costs had been incurred through
September 30, 1998, and the Company expects to incur the balance of such costs
to complete the compliance plan. The Company has been expensing and capitalizing
the costs to complete the compliance plan in accordance with appropriate
accounting policies. Variations from anticipated expenditures and the effect on
the Company's future results of operations are not anticipated to be material in
any given year. However, if year 2000 modifications and conversions are not
made, or are not completed in time, the Year 2000 problem could have a material
impact on the operations and financial condition of the Company.
THE ESTIMATES AND CONCLUSIONS HEREIN ARE FORWARD-LOOKING STATEMENTS AND ARE
BASED ON MANAGEMENT'S BEST ESTIMATES OF FUTURE EVENTS. RISKS OF COMPLETING THE
PLAN INCLUDE THE AVAILABILITY OF RESOURCES, THE ABILITY TO DISCOVER AND CORRECT
THE POTENTIAL YEAR 2000 SENSITIVE PROBLEMS WHICH COULD HAVE A SERIOUS IMPACT ON
CERTAIN OPERATIONS AND THE ABILITY OF THE COMPANY'S SERVICE PROVIDERS TO BRING
THEIR SYSTEMS INTO YEAR 2000 COMPLIANCE.
Forward-looking Statements
Certain statements in this Quarterly Report on Form 10-Q/A constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance, or achievements of the Company to be materially different
from any future results, performance, or achievements expressed or implied by
such forward-looking statements. Important assumptions and other important
factors that could cause actual results to differ materially from those in the
forward-looking statements, include, but are not limited to: the effect of
economic and market conditions, the ability to obtain financing, the level and
volatility of interest rates, the outcome of the pending litigation relating to
the accounting irregularities at the Parent Company, the ability of the Company
and its vendors to complete the necessary actions to achieve a year 2000
conversion for its computer systems as applications, the effect of any corporate
transactions, including any divestitures, and other risks and uncertainties.
Other factors and assumptions not identified above were also involved in the
derivation of these forward-looking statements, and the failure of such other
assumptions to be realized as well as other factors may also cause actual
results to differ materially from those projected. The Company assumes no
obligation to update these forward-looking statements to reflect actual results,
changes in assumptions or changes in other factors affecting such
forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In normal operations, the Company must deal with effects of changes in interest
rates and currency exchange rates. The following discussion presents an overview
of how such changes are managed and a view of their potential effects.
The Company uses various financial instruments, particularly interest rate and
currency swaps, but also options, floors and currency forwards, to manage its
respective interest rate and currency risks. The Company is exclusively an end
user of these instruments, which are commonly referred to as derivatives.
Established practices require that financial instruments relate to specific
asset, liability or equity transactions or to currency exposure.
The Securities and Exchange Commission requires that registrants include
information about potential effects of changes in interest rate and currency
exchange in their financial statements. Although the rules offer alternatives
for presenting this information, none of the alternatives is without
limitations. The following discussion is based on so-called "shock tests", which
model effects of interest rate and currency shifts on the reporting company.
Shock tests, while probably the most meaningful analysis permitted, are
constrained by several factors, including the necessity to conduct the analysis
based on a single point in time and by their inability to include the
extraordinarily complex market reactions that normally would arise from the
market shifts modeled. While the following results of shock tests for interest
rate and currencies may have some limited use as benchmarks, they should not be
viewed as forecasts.
o One means of assessing exposure to interest rate changes is a
duration-based analysis that measures the potential loss in net earnings
resulting from a hypothetical 10% change in interest rates across all
maturities (sometimes referred to as a "parallel shift in the yield
curve"). Under this model, it is estimated that, all else constant, such an
increase, including repricing effects in the securities portfolio, would
not materially effect the 1998 net earnings of the Company based on current
positions.
o One means of assessing exposure to changes in currency exchange rates is to
model effects on reported earnings using a sensitivity analysis. Period
ended March 31, 1998 consolidated currency exposures, including financial
instruments designated and effective as hedges, were analyzed to identify
the Company's assets and liabilities denominated in other than their
relevant functional currency. Net unhedged exposures in each currency were
then remeasured assuming a 10% change in currency exchange rates compared
with the U.S. dollar. Under this model, it is estimated that, all else
constant, such a change would not materially effect the 1998 net earnings
of the Company based on current positions.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(b) The Company filed a report on Form 8-K on March 3, 1998 reporting in
Item 5 the launching of a new medium term note program and in
Item 7 the exhibits related thereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHH CORPORATION
By: /s/ Michael P. Monaco
Michael P. Monaco
Vice Chairman and
Chief Financial Officer
By: /s/ Scott E. Forbes
Scott E. Forbes
Executive Vice President and
Chief Accounting Officer
Date: October 26, 1998